Finding Genius

by Kunal Mehta

  Proponents of the technology were quick to remind the world that the frothiness and speculation is commonplace during the early days of any major technological breakthrough. The breakthrough in this case is the financing shift that occurred through ICOs and the premise that new ideas can be funded online.

  After the bubble burst, Ravikant and other proponents of ICOs say that blockchain technology is building free open systems and creating financing mechanism where owning a token is enough to support a company. With ICOs, companies no longer need to register with the SEC, and they can be freely traded around the world. This system threatens capitalists who work with companies over a 3-10 year period until they achieve an IPO. With ICOs, entrepreneurs can raise a small amount of venture funding and work towards an ICO as the next step instead of raising Series A, B, or C financing. This squeezes venture capital and forces it to operate in a small segment of the market as opposed to owning the entire financing chain of a company. While this may be exciting progress, ICOs often offered coins at absurd valuations and protections were not built from investors losing all of their money. In 2019, the reputation of ICOs became so toxic that most investors were staying away until the industry had more regulation and systems in place. Neil Devani, an investor in Silicon Valley, wrote in his blog about the emergence of cryptocurrency and what it could mean for venture capital:

  “[Blockchain] has opened startup investing to a global capital market bringing unprecedented liquidity, drawing from a now inflated set of currencies. The increased demand and liquidity premium has resulted in companies that can’t raise a $2 million round from VCs raising $20 million from crypto investors, with returns expected from speculation versus revenue or profit. Losses have mounted as Bitcoin trades at a ~80% discount to its all-time highs, but the appeal of liquidity in an otherwise illiquid asset (startup equity) and investing from an inflated asset will remain strong. As the hype and easy money fade, future investment will depend more on the performance of existing investments. In 2013, there were 39 unicorns (tech startups valued at $1B or more), with four more created annually. Five years later there are 146 unicorns and we’re adding about 15 annually. That said, unicorns are arguably overvalued by almost 50% on average. It’s hard to envision all of these companies growing into or exiting at these values.”

  Inherent Bias & Leveling the Venture Playing Field

  A fundamental area that entrepreneurs and venture capitalists continue to explore in 2019 is the extent of human bias in venture capital. Examined from another perspective: are humans capable of evaluating true genius or can this be a data-driven exercise? Early stages of investing are inherently characterized by a lack of data and proof points, so many investments are made on conviction or loosely-held theses. Investors who backed companies like Lyft or Airbnb in the early days say that in the absence of traction, they trusted their gut instinct that those founders would go on to succeed. Artificial intelligence (AI) cannot quantify or program gut instinct. Rational computers would almost always shoot down startup endeavors given the irrationality of these experiments and the low likelihood of success. Does the human element of optimism or conviction to shoot for the stars make venture capital as compelling as it is? I will leave the overall debate on AI versus human investment for another time, and here, put an emphasis instead on human-centered investing — specifically, the responsibility investors have to create equanimity within the startup ecosystem.

  The individuals who manage the capital behind the entrepreneurs who will re-shape the future share a moral obligation to humanity. In order to create and support businesses and enterprises that represent the values that all humans hold important, it’s critical that all minorities, socioeconomic groups, and genders be represented in this future environment of venture capital. And it comes down to this: the responsibility for a level playing field falls squarely on the shoulders of early-stage venture capitalists who are deciding who is given a fair shot at shaping this future, and who is not. Currently, this is not the case — far from it. While the venture capital industry tends to pride itself on being progressive, it’s reared its ugly head time and again by excluding large swaths of people from the opportunity to showcase their genius.

  In 2019, the extent of the diversity problem in venture capital and technology cannot be overstated. As Rebecca Kaden of Union Square Ventures puts it:

  “The venture market is not efficient. If you look at the statistics of the number of women or minorities that have raised venture capital as a percentage of the total number of entrepreneurs that have received venture capital, you can’t honestly say that every founder that deserves venture capital is getting venture capital.”

  Despite what some of the investors I spoke with claimed about why this problem exists and why they believe that venture capital is in fact efficient, I fundamentally agree with Kaden’s point. The venture market is not efficient. It leaves large groups of individuals and geographies marginalized. Women-only teams historically raised about 2% of all venture capital while all-male teams raised about 80% of it. According to CB Insights, in 2016, less than 1% of venture capital funded founders who were black. Considering these statistics, ‘genius’ has been defined from a very myopic perspective, skewed in favor of certain groups of individuals. One cause is selection bias. Most partners at venture capital funds have historically been white males and oftentimes, even if unwittingly, have associated with founders who resemble their own professional, socioeconomic, or educational backgrounds. Defining genius based on how they have been trained their entire lives, these VCs have a bias that has created serious inequality in the venture and technology ecosystem. The National Venture Capital Association (NVCA) reported that, in 2016, 11% of venture capital firm investment partners were women. In terms of ethnicity, 13% were Asian; 2% Hispanic; and 0% black. Melinda Gates, an advocate to change this disproportion, wrote in a ReCode post:

  “While the average investment in companies led by men jumped 12 percent, to $10.9 million, the average investment in companies led by women dropped 26 percent, to $4.5 million… The people who are running these VC funds aren’t necessarily setting out to be exclusive or discriminatory. But even so, there is a lot of evidence that unconscious biases are impacting the way female founders are received. Consider, for example, the finding that investors tend to describe young male entrepreneurs as “promising,” and young female entrepreneurs as “inexperienced.” Or that the managing partner of one of Silicon Valley’s leading VC firms admitted that one of the things he looks for when deciding whether to invest is an entrepreneur who fits the Gates, Bezos, Andreessen or Google model — which is to say, “white male nerds who’ve dropped out of Harvard or Stanford.”

  In 2018 and 2019, this conversation finally became front and center. AllRaise, a nonprofit launched by 34 female women partners at prominent venture capital funds, aimed to transform the industry by mentoring and creating additional opportunities for female founders and investors. AllRaise has facilitated networking opportunities between female founders and female venture capitalists, it has encouraged the broader community to support diversity at their own funds, and more importantly, it has forced this conversation to happen on center stage. Simultaneously, Arlan Hamilton, the founder of Backstage Capital, has exhibited the traits of ‘genius’ venture capitalists search for — an unwillingness to fail, a tolerance for criticism, recruiting acumen, and a proficiency for storytelling — as she has risen from poverty to launch a venture capital fund focused exclusively on funding minority and female founders. Hamilton’s story is inspiring and reveals that founders like herself are often discounted because they did not have a similar background to the investors who controlled the majority of venture capital. Other funds, such as Female Founders Fund (Sutian Dong, who wrote the prologue for this book, is a partner with Female Founders Fund) and Unshackled Ventures, have also done their part in driving this shift.

  This change can be enforced by Limited Partners who fund venture capitalists committed
to creating this more efficient startup market. Jenny Abramson, the Founder and Managing Partner of Rethink Impact, an impact-focused venture capital fund dedicated to investing in women, discusses the importance of finding a diverse LP base that respects the investments she makes:

  “Our LP base is ~50% women. If you think about most venture dollars in this country, they come from the coasts (primarily from New York and California). Our LP dollars are coming from 32 different states, from people on both sides of the aisle, and from foundations and other sources. We think that when you get this notion of women investing in women who are investing in women, you start to turn the tables on the gender gap in the startup industry. If you follow the expected transfer of wealth in the coming years, I believe you’re going to start to see even more shifts in the dynamic. Millennials, as they inherit wealth and make investment decisions, will also cause shifts, both on the impact side and on the gender side. Both groups care deeply about investing with impact, even more so than previous generations.”

  I find the trends in venture capital to be particularly disturbing, but I remain optimistic that the efforts by female investors like Beth Ferreira, Jenny Abramson, Arlan Hamilton, and Rebecca Kaden will continue to level the playing field for entrepreneurs. Led by the example of these individuals, this issue is being rectified by both men and women across the venture capital industry.

  In writing this book, I set out to capture a diverse set of perspectives to define ‘genius,’ and in doing so, I was fortunate to connect with investors who represent the gender, socioeconomic, racial, and geographic diversity that I anticipate venture capital will eventually come to represent. Each of these investors has agreed to share their insights in an even more transparent way; they’ve each written a chapter with their own investment thesis, which I will share in the next section.

  Geographical Distribution

  Venture capital should play a vital role and support the entrepreneurial ecosystem in emerging economies. Unfortunately, venture capital dollars have historically not been evenly distributed across the US or internationally. As venture capital came to prominence, the first funds settled in Boston to be in close proximity to prominent academic institutions and the talent that was drawn to them. Over time, the venture capital industry consolidated in Silicon Valley, which still dominates much of the mindshare of the venture ecosystem. New York and Philadelphia have risen as contenders with massive companies being built out of these cities including companies like Glossier and Pinterest.

  As the cost of building a company goes down and access to talent becomes less about location and more about skill — regardless of location — the geographic distribution of venture capital should follow suit. If venture capital is more decentralized and democratic, entrepreneurs in emerging entrepreneurial hubs gain new access to capital. Cities like St. Louis or Detroit present massive opportunities for founders who want to partner with large corporations in verticalized industries such as agriculture, automotive and transportation, and insurance.

  Cliff Holekamp, a professor with Washington University and a venture capitalist with Cultivation Capital, is focused on supporting and retaining entrepreneurs to build businesses within the Midwest. Raised in California but transplanted to St. Louis, Holekamp has seen the United States transition from a country dependent on its manufacturing states that thrived given their industry dominance and technical prowess to now investing heavily into its technology and financial sectors. Holekamp discusses how these cities have evolved:

  “St. Louis, a rustbelt city, was one that was heavily dependent on manufacturing and was famous for its high proportion of Fortune 500 companies headquartered there until the 1980s. In the 1980s those companies started to be acquired by multinationals or went out of business (Purina by Nestle, Anheuser Busch bought by InBev). We were a company town, our students and residents worked at these companies. We got too confident and no one planned for the adverse. That’s typical of the Midwest and we’ve seen it play out in most cities across the United States. There were a lot of old-school manufacturing companies that in their heyday were thriving but as the economy changed and evolved, these cities were not entering into the future and were suffering as a result of change. They were being, as a Silicon Valley investor might put it proudly, ‘disrupted.’ In Chicago, venture capital was slow to grab a foothold. These large cities were focused on industry, but these industries were not evolving. In 1904, St. Louis was a thriving metropolis and the fourth largest city in America. Since then, the city became complacent and lost its focus on innovation and entrepreneurship. By the end of the 20th century, it just wasn’t in the DNA of our people anymore. We were big company people but as those big companies failed, we needed to evolve. In fact, we had to evolve. Around 2012, we began to force this change.”

  Holekamp reflects on a trend I noticed as I traveled to cities across the United States for Disruptors. In small towns such as Aberdeen, South Dakota or Pippa Passes, Kentucky, entrepreneurs with bold ideas are not being provided with the same opportunities as entrepreneurs on the coasts are being given. It is less of a financing problem and more so a knowledge gap on what is available to these founders. The outlier geniuses that do emerge in these towns end up abandoning their communities and building their businesses and hiring teams in the economies of Boston, New York or San Francisco. Holekamp began to focus on building a robust ecosystem that retained its entrepreneurs. He says:

  “When we started, we held competitions that gave entrepreneurs $50,000 to start. There was no follow-on capital. So as a result, those companies would be seeded in St. Louis but then they would have to move to California or New York to get that next round of capital. We launched Cultivation Capital to fund companies through the Series-A round so that we can create an ecosystem to allow them to stay in this city. Angel markets were local but follow-on capital was elsewhere.”

  Entrepreneurship is meant to be a democratic vertical where ‘geniuses’ can start a company without too much restriction. The problem that exists in 2019 is not only that the opportunities are not equally available to women or people of color, but they’re also out of reach to ‘geniuses’ who are bound by the places they are born. Holekamp is one investor focused on addressing the geographic distribution of wealth and venture capital. Another is Steve Case, the former CEO of America Online who partnered with Revolution’s Rise of the Rest fund, which is specifically designed to fund entrepreneurs outside of the coastal cities. Their portfolio spans multiple industries but is able to identify unique opportunities, such as Freightwaves out of Chattanooga, Tennessee, a fast-growing company building telematics software for the freight industry. Given that he has grown up surrounded by the freight industry, Craig Fuller, the founder of Freightwaves, has the unique insight and determination to solve problems that he has witnessed his entire life.

  Holekamp believes that access to talent and a capital network are important to foster and support entrepreneurial genius but places importance on a ‘dense ecosystem’. He says:

  “We need talent and capital in an environment that is dense enough to create a community — which I define as a group of people with shared experiences. When you create a community, it defines a culture and that culture attracts more people to join the community. The big enemy to entrepreneurial communities is lack of density because if you don’t have people physically located near one another and sharing their ideas around common experiences, they’ll never bind to one another’s challenges and struggles or inspire one another with success and vision. We didn’t initially understand the important interplay between talent, capital, and density, but fortunately, these essential three elements all came together in downtown St. Louis at the T-REX incubator around 2012. We ended up with enough critical mass and that created the genesis that has built upon itself and given us the momentum we have today.”

  Looking to the Future and Avoiding the Hype

  From 2007-2019, mobile smartphones opened up opportunities for new venture-scale
businesses. With high-quality cameras in everyone’s pocket, Instagram and Snapchat were concepted as mobile-first businesses. As GPS technology was embedded into these handheld devices, companies such as Uber, Lyft, and Waze, became integral to our everyday lives. The surge in smartphone usage was followed by a decrease in the cost of the device while the chips in these devices continued to evolve and support more activities. In 2017, consumers saw augmented reality (AR) and virtual reality (VR) startups leverage smartphones to change the way we interact with the world around us. Over the past decade, smartphones have been an entry point for people in developing countries to access financial credit, remain in contact with their friends and families, monitor the health of their businesses, and gain access to important knowledge previously not available to them. In 2018, Apple paid developers who built and monetized apps on the Apple App Store over $38 billion and venture capitalists were behind many of those projects. In China, applications such as WeChat on mobile dominate everyday life through transactions, communication, entertainment, and commerce.

  As smartphone penetration compounds, mobile devices and their users continue to produce treasure troves of data. For storage needs, VCs backed cloud infrastructure projects; and for projects that leveraged smartphone data, they backed geniuses solving problems in healthcare, communication, productivity, education, social, and one of the most lucrative of all, mobile gaming. As this data is stored, new applications for artificial intelligence have emerged and venture capitalists are funding opportunities at the intersection of machine learning, computer vision, and smart devices. Through machine learning, robotics have become a hot investment area for venture capitalists who are funding companies that aim to automate mundane tasks from invoice processing to packing boxes. VCs have also been eager to fund the next-generation AI projects and are funding companies surrounding autonomous vehicles to the tune of hundreds of millions of dollars a year.